Transaction Costs and Market Institutions: Grain Brokers in Ethiopia

9
trader’s social capital and acts as a positive shifter in the trader’s revenue
function. The trader’s revenue maximization is expressed by
(1) = γ L α K β e ε - ωL - νK
where γ is social capital, ω is the opportunity cost of search labor (L), and ν is
the opportunity cost of working capital (K). From the first-order conditions for
profit maximization, the shadow opportunity costs of search labor ω *
and of
working capital ν * are derived as
α
(2) ω
* = R L
β
(3) ν
* = R K
Ordinary least squares estimation of the trader’s revenue function would result in
asymptotically biased estimators because of the simultaneity bias that exists
because both search labor and working capital depend on revenue and thus will
not be independent of the model’s error term. 5
To overcome this bias, two-stage
least squares estimation is used to obtain the coefficients necessary for deriving
ω* and ν*. A rich set of instruments for search labor and working capital are
5
This issue generally plagues the estimation of production functions, to which a solution is to
apply duality theory, a solution which fails to use all available information and is statistically
inefficient (Mundlak, 1996). In this case, the existence of a rich set of instruments provides a
more convincing instrumental variables estimator.